Five Things to Know About Redlining Risk and the First Merchants Bank Settlement
Earlier this summer, the U.S. Department of Justice (“DOJ”) announced a settlement with First Merchants Bank, a non-member bank headquartered in Muncie, Indiana (“FMB”), regarding allegations of discriminatory lending often referred to as “redlining.” According to the DOJ’s lawsuit, FMB engaged in unlawful redlining of majority-Black census tracts in violation of the Fair Housing Act (“FHA”) and the Equal Credit Opportunity Act (“ECOA”). [1]
FMB agreed to settle the lawsuit without a formal adjudication or factual finding and is now subject to a four-year, multi-faceted enforcement order under federal court oversight. The DOJ’s Complaint and Settlement Order with FMB illustrate important aspects of compliance with federal fair lending laws, including how changes in a bank’s business due to mergers, acquisitions, branch attrition, or new lending patterns can elevate redlining risk. Along with the earlier settlement of similar claims against KleinBank in 2018, the FMB Settlement Order marks the second fair lending settlement entered into by the DOJ under the Trump Administration. Accordingly, community banking institutions may want to consider fair lending compliance and redlining risk at their institutions.
I. What is redlining?
Redlining occurs when a bank avoids providing banking products and services to segments of its market area on the basis of race or ethnicity. The term comes from the 1930s, when the Federal Housing Administration used colored-coded maps to classify residential neighborhoods throughout American cities. [2] Blue and green areas indicated neighborhoods with desirable, in-demand housing. Such neighborhoods were overwhelmingly (if not completely) White, which were deemed a safe bet for government-funded mortgage insurance. By contrast, neighborhoods with Black residents were shaded red and deemed ineligible for mortgage insurance. Redlined neighborhoods excluded Black Americans from the mortgage industry throughout a significant portion of the twentieth century. Redlining is now prohibited under the FHA and ECOA. [3]
II. What were the allegations against First Merchants?
The Complaint alleges that, from 2011 to at least 2017, FMB intentionally avoided majority-Black neighborhoods and adopted a residential mortgage lending policy that had the effect of denying residents of those neighborhoods equal access to credit in violation of the FHA and ECOA. [4]
The DOJ focused on FMB’s lending practices in the Indianapolis-Carmel-Anderson Metropolitan Statistical Area (the “ICA MSA”), including Indianapolis-Marion County (a political subdivision within the ICA MSA). The DOJ’s investigation into FMB’s multi-state footprint lasted over two years and included statistical analysis of data submitted by FMB under the Home Mortgage Disclosure Act (“HMDA”). [5] Because HMDA data contains information about the location and demographics of applicants for home purchase loans, home improvement loans, and mortgage refinancings, government agencies and advocate groups use it to evaluate potentially illegal lending practices under the FHA and ECOA. [6]
On the basis of that investigation, the DOJ alleged that FMB engaged in willful and planned discriminatory lending practices against majority-Black census tracts. The DOJ’s principal claims include the following:
- FMB failed to open or maintain any branches in the majority-Black areas of Indianapolis-Marion County;
- FMB refused to market its banking services to majority-Black areas of Indianapolis-Marion County;
- Compared to its peer banks, FMB disproportionately solicited fewer loan applications and originated fewer loans in majority-Black neighborhoods; and
- FMB had a residential mortgage lending policy that established a preference for lending based on location, rather than creditworthiness. [7]
III. How did FMB’s CRA assessment area provide evidence of potential redlining?
In its Complaint, the DOJ tied FMB’s unlawful lending practices to assessment areas established and maintained by the bank under the Community Reinvestment Act (“CRA”). According to the DOJ, those assessment areas revealed the bank’s intent to deny residents in majority-Black census tracts equal access to real estate credit.
Congress passed the CRA in 1977 to reduce discriminatory lending practices against low-income and moderate-income neighborhoods. [8] The CRA encourages banks to meet the credit and investment needs of their local communities and requires that federal bank regulators regularly assess banks’ CRA performance. [9] To that end, banks delineate a CRA “assessment area” that consists of one or more metropolitan statistical areas or contiguous political subdivisions (e.g., counties, cities, towns) in which they have their main office, branches or deposit-taking ATMs. [10]
Often it is the case that a bank’s CRA assessment area will vary with time as a result of mergers, acquisitions, branch openings and closings, and changing lending patterns. But, because this is a bank-driven process, banks may designate the surrounding areas in which they originate or purchase a substantial portion of loans and then adjust the assessment area as reasonably necessary to reflect actual service areas. A key restriction is that such adjustments may not reflect illegal discrimination. [11] According to the DOJ, FMB’s failure to maintain a non-discriminatory CRA assessment area was at the heart of its fair lending violations.
Based northeast of Indianapolis in Muncie, FMB initially delineated only parts of the ICA MSA as its assessment area. Then, from 2011 to 2015, FMB significantly expanded through mergers and acquisitions, adding several predominately White counties in the ICA MSA to its assessment area. However, FMB cut Indianapolis-Marion County (part of the ICA MSA) from its assessment area, which had the effect of excluding all but one majority-Black census tract within the ICA MSA. [12] Consequently, at the end of 2015, FMB’s assessment area resembled a horseshoe-shape that, according to the DOJ, gerrymandered around the majority-Black areas of the ICA MSA to include only predominately White census tracts.
Then, in 2016, FMB closed another bank acquisition that added Indianapolis-Marion County to its assessment area. This acquisition gave FMB the opportunity to close its “horseshoe” and expand its assessment area into contiguous majority-Black neighborhoods. The DOJ alleged, however, that FMB continued its practice of discrimination with respect to the majority-Black census tracts in the ICA MSA: managing its branching footprint (closing, opening, and consolidating branches) and marketing to serve the needs of predominately White census tracts, but allegedly discouraging Black loan applicants from seeking credit, failing to open or operate a branch within any of the 50 majority-Black census tracts within Indianapolis-Marion County, and consistently underperforming its peers with respect to minority lending. Thus, according to the DOJ, FMB failed to reach out to majority-Black census tracts within its CRA assessment area in any meaningful way.
IV. What is FMB required to do under the Settlement Order?
Under the Settlement Order, which is subject to the continuing jurisdiction of the U.S. District Court for the Southern District of Indiana, FMB will expand its marketing efforts, lending, and banking services to specifically include majority-Black neighborhoods in Indianapolis-Marion County. FMB will invest $1.12 million in a loan subsidy fund to increase credit opportunities to residents of majority-Black neighborhoods, and will devote $500,000 toward advertising, community outreach, and credit repair and education. FMB will also open a branch and loan production office to serve the banking and credit needs of residents in majority-Black neighborhoods in Indianapolis-Marion County. Lastly, FMB will employ a director of community lending and development who will oversee these efforts and work in close consultation with bank leadership. [13]
V. What are the key take-aways from the FMB matter?
1. The DOJ and U.S. Attorney’s Offices continue to focus on redlining.
The Settlement Order marks the second fair lending settlement entered into by the DOJ under the Trump Administration. [14] Interestingly, this case was raised by the DOJ on its own accord without participation by FMB’s primary federal regulator – the FDIC. In fact, the FDIC is not a party to the Settlement Order, which, unlike typical supervisory enforcement actions, remains subject to federal court oversight. This suggests that, although federal bank regulators may have shifted enforcement resources to other areas, the DOJ and U.S. Attorney Offices continue to focus on fair lending, redlining, and other discriminatory credit practices.
2. Inaction by a bank’s primary federal regulator does not guarantee that the federal government will not bring an action.
It is noteworthy that during the course of the DOJ’s investigation (which began in 2017 and concluded with the lawsuit and Settlement Order in June 2019), the FDIC conducted an evaluation of FMB’s CRA performance. The FDIC’s evaluation included consideration of FMB’s performance under the CRA’s lending, investment, and service tests for its assessment areas from March 2015 through June 2018. Although the FDIC gave FMB a “low satisfactory” CRA exam rating for all three tests, its “examiners did not identify any evidence of discriminatory or other illegal credit practices.” [15] This, of course, stands in direct contrast to the allegations in the DOJ Complaint and the requirements of the Settlement Order.
3. Banks should be cognizant that changes to operations, business, or market footprints can create issues for discriminatory practices compliance.
The FMB case demonstrates that banks should be vigilant and proactive in monitoring compliance with anti-discriminatory regulations and identifying opportunities to strengthen policies and procedures, training, and internal controls to ensure that discrimination does not occur. In particular, banks that have gone through a corporate or business expansion or reorganization (including a merger, acquisition, or consolidation), have enlarged or changed their product offerings or branch footprint, or have underperformed their peers with respect to minority lending, should take action to assess and avoid any practices or conditions that could lead to fair lending enforcement. Such banks may wish to conduct an internal evaluation of redlining risk by transferring the bank’s activities to a map in order to visualize any patterns. In addition to the classic “donut hole” pattern, federal bank regulators have also found “horsehoe” branch and lending footprints to be problematic when an urban core is excluded.
4. Banks should monitor and assess compliance annually.
A close review and assessment of bank policies, procedures, compliance management system, and community outreach efforts should be an annual exercise. It can be easy to think that, because no problems arose in a prior year, that the bank’s compliance and outreach efforts do not need to be reviewed or updated. But this is not the case. Annual assessment of redlining risk in conjunction with strategic adjustments to bank lending activity, marketing, and community outreach efforts is a key component of maintaining a health compliance posture.
[1] See Complaint, USA v. First Merchants Bank, No. 1:19-cv-02365 (S.D. Ind., filed June 13, 2019); available at: https://www.justice.gov/opa/press-release/file/1173131/download.
[2] The maps were developed by the Home Owners’ Loan Corporation and adopted by the Federal Housing Administration for use in mortgage insurance determinations. Two useful primers on redlining are: (1) Federal Reserve, Consumer Compliance Supervision Bulletin, “Fair Lending” (July 2018), available at www.federalreserve.gov; and (2) The Fair Housing Center of Greater Boston, 1934-1968: FHA Mortgage Insurance Requirements Utilize Redlining, available at www.bostonfairhousing.org.
[3] To address concerns about fair access to credit, Congress passed the FHA in 1968 and ECOA in 1974.
[4] See generally, Complaint, USA v. First Merchants Bank, at p. 1 (citing the FHA, 42 U.S.C. §§ 3601-3619, and the ECOA, 15 U.S.C. §§ 1691-1691f) and pp. 3-12.
[5] The HMDA was enacted by Congress in 1975 and was implemented by the Federal Reserve’s Regulation C. On July 21, 2011, the rule-writing authority of Regulation C was transferred to the Consumer Financial Protection Bureau. Regulation C requires lending institutions to report public loan data, which is accomplished via submission to a database maintained by the Federal Financial Institutions Examination Council.
[6] “While HMDA data provide a useful start in assessing lending practices, the data alone do not prove discrimination. If HMDA data trigger concern, bank examiners conduct a comprehensive review, including an in-depth statistical analysis. The statistical analysis looks for legitimate credit underwriting factors, such as minimum credit scores and maximum debt-to-income ratios.” J. Stackhouse, “Do Home Mortgage Disclosure Act Data Prove Lending Discrimination?” On the Economy Blog, Federal Reserve Bank of St. Louis (March 22, 2018), available at: https://www.stlouisfed.org/en/on-the-economy/2018/march/do-hmda-data-prove-lending-discrimination.
[7] See Complaint, USA v. First Merchants Bank. pp. 4-5.
[8] Each federal bank regulator has promulgated its own regulation under the CRA: 12 C.F.R. Part 25 (regulations of the Office of the Comptroller of the Currency applicable to national banking associations); 12 C.F.R. Part 228 (regulations of the Federal Reserve applicable to state member banks); and 12 C.F.R. Part 345 (regulations of the Federal Deposit Insurance Corporation applicable to state non-member banks). The three sets of regulations are substantially similar and the three federal bank regulators use a uniform examination system. Because FMB is a state non-member bank with the FDIC as its primary federal regulator, references herein are to 12 C.F.R. Part 345.
[9] Federal bank regulators review CRA assessment areas for technical compliance (i.e., assessment area delineation is not a performance factor). As to a bank’s holistic CRA performance evaluation, federal bank regulators examine each bank on a case-by-case basis after considering facts relevant to the bank. See Interagency Questions and Answers regarding CRA Guidance, 81 Fed. Reg. 48,506, 48,548-549 (July 25, 2016) (Q&A to § .41(a)—1 and § .41(e)(3)—1).
[10] 12 C.F.R. § 345.41(c)(1).
[11] Id. at §§ 345(c) – (e). In addition, adjustments may not excise whole geographies or exclude low- or moderate-income geographies, and the bank’s assessment area may not extend substantially beyond a metropolitan statistical area boundary or a state boundary unless the assessment area is located in a multistate metropolitan statistical area.
[12] Complaint, USA v. First Merchants Bank, pp. 5-6.
[13] Settlement Order, USA v. First Merchants Bank, No. 1:19-cv-02365 (S.D. Ind., filed June 13, 2019), available at: https://www.justice.gov/opa/press-release/file/1173146/download.
[14] The DOJ’s first redlining settlement order of the Trump Administration involved KleinBank in Minnesota. See DOJ Press Release (May 8, 2018), available at: https://www.justice.gov/opa/pr/justice-department-reaches-settlement-minnesota-bank-resolve-allegations-lending. Effective November 1, 2018, KleinBank merged into and is now operated as part of Old National Bank of Evansville, Indiana.
[15] See FDIC, Community Reinvestment Act Performance Evaluation – First Merchants Bank, p. 18 (June 2, 2018).